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Economics exam 3

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Why is the demand curve downward sloping? When demand rises, this tends to cause prices to rise When demand rises, this tends to cause prices to fall When prices decrease, consumers tend to buy more When prices increase, consumers tend to buy more
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When prices decrease, consumers tend to buy more
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Which of the following factors is a demand shifter? Change in costs of production Change in price of the good Change in income Technological change which lowers the cost of production
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Change in income
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What would cause the demand curve to shift to the right? An increase in cost Income An increase in income An increase in price
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An increase in income
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Why is the supply curve upward sloping? As price rises, quantity demanded decreases As price rises quantity supplied decreases As price rises quantity supplied increases As taxes rise, quantity supplied increases
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As price rises quantity supplied increases
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What would cause the supply curve to shift to the left? A decrease in income An increase in price A decrease in the cost of production An increase in the cost of production
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An increase in the cost of production
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If the demand curve shifts to the right, what happens to price and quantity? Price rises and quantity falls Price falls and quantity rises Both price and quantity rise Both price and quantity fall
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Both price and quantity rise
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If the costs of production rise in the market for silverware, what happens in the supply and demand graph? Supply shifts left leading to an increase in price and a decrease in quantity. Supply shifts right leading to a decrease in price and an increase in quantity. Demand shifts right leading to an increase in both price and quantity. Demand shifts left leading to a decrease in price and quantity.
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Supply shifts left leading to an increase in price and a decrease in quantity.
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The stock market has increased this quarter and is at an all-time high. In terms of supply and demand, what are the two reasons for the rise in stock prices? Demand increases (shifts right) and supply increases (shifts right) Demand increases (shifts right) and supply decreases (shifts left) Demand decreases (shifts left) and supply increases (shifts right) Demand decreases (shifts left) and supply decreases (shifts left)
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Demand increases (shifts right) and supply decreases (shifts left)
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What is an example of a public good, what is the problem, and what is the solution? A. Fire protection, the market produces too much fire protection, solution is to reduce government involvement. B. Education, the problem is that tuition is too high, government should pay teachers more. C. National defense, the market does not produce enough of the service, the government must provide the service and force people to pay with taxes. D. Big macs, markets do not produce enough of the good, solution is to tax (I am just guessing, but it seems like you always think the solution is to tax).
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National defense, the market does not produce enough of the service, the government must provide the service and force people to pay with taxes.
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What is an example of a negative externality, what is the problem, and what is a solution? Education, not enough is produced, taxes. Energy production causing carbon emissions, too much carbon emissions are produced, solution is to tax carbon Cigarettes, problem is that cigarettes are too expensive, solution is to start smoking
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Energy production causing carbon emissions, too much carbon emissions are produced, solution is to tax carbon
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Name the 3 demand shifters
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change in income, change in taste or preferences, change in price of related good
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Name the 3 supply shifters
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cost to produce, Change in technology, Change in taxes.
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Why is the demand curve downward sloping?
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As price goes down, quantity demanded goes up (price change moves us along the demand curve)
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What is one factor that would cause the demand curve to shift to the right?
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Increased Popularity or Taste Preferences, Increase in Income
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Why is the supply curve upward sloping?
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As prices increases quantity supplied increases.
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What is one factor that would cause the supply curve to shift to the right?
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cost to produce decreases
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Draw a supply and demand graph for new cars. Show the impact that the 2008-09 recession (with the decrease in income) had on the market for cars. You can show this best by shifting one of the curves. What happens to the price and quantity of new cars?
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Show the impact that an increase in the cigarette tax would have on the cigarette market. Draw a supply and demand curve for cigarettes and then show the impact of the tax. (Hint: it is easiest to show the impact of a tax by shifting the supply curve rather than the demand curve.) What happens to price and quantity?
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A survey indicated that chocolate is Americans’ favorite ice cream flavor. For each of the following, indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of chocolate ice cream. a. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits. b. New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing chocolate ice cream.
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What are the two components of supply and demand?we first need to separate out the two components:
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buyers (demand) and sellers (supply).
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What is equilibrium?
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occurs when we put the two components back together
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What is the most important factor that influences how many units of a good are sold?
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Price, this is what the demand curve is all about.
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The demand curve looks at
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the quantities of a good buyers are willing and able to buy at various market prices. Looking at various possible prices, not just the current market price. *** Very important for a business person to think about before increasing or decreasing prices. ***Also note that demand occurs if the buyers would actually buy the product. In other words, the demand for diamonds is not necessarily high just because lots of people want diamonds. Demand only counts if people would buy it at the price.
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Why is the demand curve downward sloping?
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because a decrease in the price will cause an increase in quantity demanded.
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The demand curve simply plots out this relationship.
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the negative relationship between price and quantity demanded
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What factors causes movement along the demand curve, or causes the demand curve to shift?
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Change in Income, Change in tastes or preferences, Change in prices of related goods
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What is the most important influence over demand,
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Price
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Change in Income.
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For most goods, called normal goods, a change in income will cause demand to change in the same direction. For example, when the economy is running well and incomes are up, demand for most goods will increase. This includes cars, furniture, food, gas, airplane trips, etc. An increase in demand is represented by a shift to the right, as in the graph below. (When the economy goes into a recession, on the other hand, demand for most goods decreases which would shift demand to the left.)
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Change in tastes or preferences.
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This can refer to a long run trend, a seasonal trend, or simply the influence of advertising. Items that are increasing in preference might include winter coats in November, high-definition televisions, organic vegetables, or Cabbage Patch dolls. The demand curves for these products increases, which is a shift to the right. On the other hand, some items are decreasing in preference, such as swimsuits in November, VCRs, beanie babies, etc. This decrease in demand is represented by a shift to the left.
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occurs when we put the two components back together
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equilibrium
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Change in prices of related goods.
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Here it matters whether the goods are substitutes or complements
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Substitutes
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goods that you buy one or the other of, such as Coke and Pepsi or butter and margarine. If the price of a substitute good increases (price of Coke) the demand for the other good will increase (demand for Pepsi).
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Complements
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are goods that you consume together, such as peanut butter and jelly or milk and cereal. If the price of a complement increases (price of peanut butter) the demand for the other good will decrease (demand for jelly).
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What impact does price have on supply decisions.
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The supply curve looks at the various quantities of a good that suppliers are willing and able to supply at various market prices.
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In the market for roses, what would be the quantity supplied if the price of roses was expected to be very low, such as $2 a dozen.
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You might at first think that supply would be high because consumers would want to buy a lot of roses. However, a business person thinking in those terms would quickly go bankrupt. $2 a dozen would probably not even cover your costs. What lies behind supply decisions are the costs of production. You want to compare prices with your costs. So, quantity supplied would in fact be very low at low prices because it just would not be profitable to be in this business.
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Why is the supply curve upward sloping?
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As the price increases, businesses have a greater incentive to supply the product.
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in supply, as price of product increases what happens to supply?
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As the expected price of a product increases, businesses would now have a greater incentive to supply the product. Thus, as price increases, quantity supplied increases. If the expected price increases from $2 a dozen to $20 a dozen, then you would supply more. The supply curve graphs this relationship between price and quantity supplied. As the price increases, businesses have a greater incentive to supply the product. Thus, we get an upward sloping supply curve.
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Supply: Change in costs (or input prices).
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In the rose example, suppose that the cost of fertilizer decreases. This means that you will be willing to supply more roses at any given price. The supply curve has increased, which is represented by a shift to the right. (Note that increases to either demand or supply are represented by a shift to the right. A common mistake with supply is to think of this as a downward shift. However, pay attention to the quantity axis. An increase in supply is increasing quantity.) Thus, a decrease in costs shifts supply to the right. An increase in costs, on the other hand, leads to a decrease in supply, which is a shift to the left.
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Change in technology.
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This is very similar to a decrease in costs…the technological advance hopefully will result in products being produced at a lower cost. Since costs are decreasing, supply will shift to the right.
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Change in taxes
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This can also be fit into the change in cost category. An increase in taxes, such as an increase in the gas tax, increases costs. Thus, we can analyze the impact of this by thinking of it as a shift to the left of the supply curve.
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Equilibrium.
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The equilibrium price is the price where quantity demanded is equal to quantity supplied. The quantity is referred to as the equilibrium quantity. The equilibrium price occurs at the point of intersection between the demand and supply curves. The equilibrium price in the rose example occurs at a price of $10 per dozen roses. At a price of $10, quantity demanded is equal to quantity supplied. (equilibrium price is typically the price we see in the market place)
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Why don’t we see a higher price? If price is higher than the equilibrium price,
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quantity demanded will be lower—fewer people will buy roses if the price is $20. On the other hand, quantity supplied might be higher—suppliers would have greater incentive to supply roses if they could get a higher price. However, this results in a surplus of roses—quantity supplied is greater than quantity demanded. What will happen? As long as the market is competitive, sellers will start lowering their prices to sell their surplus. This will continue until we move back to the equilibrium price.
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What if price were below the equilibrium price?
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Quantity demanded would be very high, but quantity supplied would be low. This would result in a shortage. The way that the market system solves a shortage is for the price to be bid up. As the price rises, quantity demanded starts to fall and businesses have a greater incentive to increase quantity supplied. Price will continue to increase until we reach the equilibrium price.
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The supply curve is mainly shifting when:
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costs are changing
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demand curve is mainly shifting when:
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there is a change in income, taste or preferences and the price of related goods
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What happens in the wood market in Miami when it is reported that a hurricane is approaching? To show this, draw in the initial demand and supply curves (D1 and Supply in the graph on the next page), with the initial price P1 and quantity Q1.
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As the hurricane approaches, there is an increase in preferences for wood to protect homes. Thus, the key change is coming from the demand side of the market. Nothing is causing the costs of producing wood to change, so the supply curve does not shift. The demand curve increases, shifting to the right.
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What happens to the price and quantity of wood? If price stayed the same there would be a large shortage of wood in the Miami area.
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However, this shortage pushes up the price. The equilibrium moves from A to B. The quantity of wood increases from Q1 to Q2 and the price of wood increases from P1 to P2. People want more wood and they get more wood. The reason they get more wood is because the price is bid up, which gives businesses a greater incentive to bring wood into the Miami area
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The market system
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moves resources around based on the interaction of thousands of individual sellers (supply) and buyers (demand). The rise in price is the key signaling mechanism of the market economy, giving businesses an incentive to provide more of the product. The market system tends to be much more efficient than a government controlled economy, meaning that we see few shortages or surpluses.
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How is the market system unfair?
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If the price of wood did not increase, quantity demanded would have been much higher. However, as the price increases, some people are priced out of the market. This may particularly hurt the poor. The market system is efficient in the sense that price adjusts to clear the market and we do not get shortages and surpluses, but there is nothing necessarily fair about the market system.
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What is the impact of increased security costs in the market for air travel?
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The key here is that costs are changing. There is an increase in cost for providing air travel. Since costs are rising, this will lead to a decrease in supply, which is a shift to the left. Price increases and quantity decreases. Demand is affected in the sense that we move to the left on the demand curve, but demand itself does not shift. As the price rises, quantity demanded decreases. So, an increase in the cost of production shifts supply to the left, but demand stays the same. This will cause equilibrium price to increase and equilibrium quantity to decrease.
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What causes the market system to functions best?
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when businesses face competition. It is that competition that pushes businesses into doing good things. We will now look at situations where the market system runs into problems. Some of these problems are debated between Classical and Keynesian economists as to how big the problem is and whether the government should get involved to correct the situation.
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What happens if public goods are left to the market system? Whats the solution?
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people stop paying for the good and the good ends up being underprovided or not provided at all. The solution? is for the government to step in to provide the good and to then force people to pay for it with taxes. Note that you have to force people to pay for the good because of the free-rider problem. One of the many internet scams/myths related to the IRS is that you only have to pay taxes that are going to programs that you support. This is certainly not true. And, if we set up taxes in that way, then people would have an incentive to lower their taxes by saying that they do not support a program.
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Problems in the Market System
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1. Public Goods 2. Externalities 3. Information Problems 4. Market Power
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There are certain goods and services for which the market system is incapable of providing in adequate quantities TRUE/FALSE
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TRUE
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Public Goods
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There are certain goods and services for which the market system is incapable of providing in adequate quantities.
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If left up to consumers would we have an increase or a decrease in public goods such as national defense
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decrease without government involvement
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Two characteristics of Public Goods:
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Non excludable and Non deplorable or non rival
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Non excludable
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This means that non-payers cannot be prevented from obtaining the benefits of the good or service. Note that this can occur with smaller issues than national defense. Streetlights, for example, face the same issue. If my neighbors all pay for a streetlight, but I do not, I can still obtain the benefits…the streetlight does not switch off when my car goes down the street. This is also known as the free-rider problem…people can take a free ride and obtain the benefits without paying. From a business perspective, this would be a big problem if you are trying to make money selling the good.
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Non-depletable or Nonrival.
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This means that one person’s use of the good does not deplete the good; does not prevent someone else from obtaining the benefits. Most goods are depletable. If you buy a Big Mac and consume it, for example, that prevents someone else from consuming that same Big Mac. With a streetlight, on the other hand, if one person uses the streetlight it is not depleted…someone else can come along (a non-payer) and also use the streetlight.
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Positive Externalities
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occur when the production and consumption of a good or service results in a positive spillover for society.
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Externalities. A second problem in the market system occurs with externalities.
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The market system works best when all of the costs and benefits of production and consumption are being taken into account. When they are not, we run into the problem of externalities, both good and bad.
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Negative Externalities occur when the production and consumption of a good or service results in a cost being imposed onto society.
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The business is not paying for all of the costs of production. Examples include (1) the production and consumption of goods, such as energy, that emit carbon, which leads to climate change, (2) cigarette consumption, and (3) the production and consumption of processed foods with added sugars, fats, and salt which contributes to obesity and other health problems. Pollution imposes a cost onto society that the business is not paying for. The consumption of cigarettes imposes a cost onto society because the illnesses associated with cigarette smoking are often expensive and largely paid for by society (rather than the smoker or the cigarette company). Processed foods with added sugars, fats, and salt contribute to health problems, which society frequently picks up the tab for.
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example of negative externalities:
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In the case of pollution, it is not that a business is dumping pollution into the environment for fun. They are often doing this to keep their costs down and their profits up. In fact, if polluting results in lower costs, consumers often end up paying lower prices (at least in the short run).
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When we are not taking all of the costs into account, we end up with too much production and consumption in these areas (compared to what would be best from society’s standpoint). Some possible solutions include:
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Taxing, fining, or suing companies to make sure that they pay for all of the costs of production. In the case of pollution, this in turn might get businesses to change their method of production in order to avoid being fined or taxed. A tax on carbon emissions is an idea that many economists have long supported to reduce carbon emissions over the long run. State governments end up paying billions of dollars in the health care costs of cigarette smokers. They have sued cigarette companies to help pay for some of these costs. Government regulations, such as limiting the amount of pollutants that businesses can emit. Selling (or giving out) pollution permits, which can then be traded in a market.
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example of Positive Externalities:
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Education is an example. One of the problems with leaving the educational system up to the market system (making all schools private) is that society benefits a tremendous amount from our educational system, not just the individuals who would be paying for their education. Businesses, for example, save billions of dollars by having our educational system educate and train their workers. Having a more educated population hopefully leads to a better functioning democracy and the public makes better voting choices. Many types of crime decrease as educational levels rise. The amount of people on welfare decreases as educational levels increase. Thus, society benefits in many ways from you going to college. The problem is that if we left education up to the market system (all private schools) many people would decide not to go to college. We would end up underproviding education. The solution is that since society benefits from education, society should help pay for education (through taxes).
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Information Problems..
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When there is a lack of good information in the market system, this can also lead to problems. This usually occurs on the consumer side of the equation. If consumers lack good information about products, this can lead to market failures.
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example of information problems
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For example, imagine a world where the government has no involvement in the food and drug industry…we just leave the production and consumption of foods and drugs totally up to the market system. The problem would be that the typical consumer lacks information about what is really in the food or drug. We cannot expect consumers to go shopping with their own mini testing laboratory. If consumers were to buy foods or drugs that harmed them, we cannot just say, “Let the buyer beware…you should not have bought the product.” The solution, in this case, is for the government (Food and Drug Administration) to test the foods and drugs on behalf of consumers as well as establish rules regarding quality, labeling, advertising, etc. In the case of the car market, the government passes regulations to help consumers make better choices and to get better cars. Note that Classical economists might argue that (1) the information problems are not that great and government action is not required and (2) if the problems are serious then consumers should be willing to pay for better information so that a new market can help solve the problem rather than government, such as with Consumer Reports.
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Market Power.
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We have already seen the problems that can arise in the market system when we do not have much competition. Over one hundred years ago, oil companies and railroads had large monopolies. This led to many problems. One problem was certainly that they charged high prices. But another problem was that they had a lot of power over society, often having their own people elected to offices. People rebelled against this monopoly power and we passed laws to try to prevent monopolies from forming. These anti-trust laws help to promote competition and make certain anti-competitive practices illegal.